This paper aims to provide an introduction to the debate on the legal position of bitcoin. It presents arguments in favour of a proper regulation system being adopted by states, as well as examples of progressive attitudes which would better accommodate the growth of this new form of currency in a legitimate and secure manner.

Introduction to bitcoin

If one were to look at the news, randomly surf through the pages of Reddit (an entertainment, social networking service and news website), or just have a chat with friends from college, I believe they would inadvertently come across the topic of bitcoin. The history of how bitcoin came to be is still unknown in its entirety. It is known that it was created by an entity that goes under the alias of Satoshi Nakamotoin in order to be a form of currency which is based on an algorithm administrated by the users of the currency and not by a single governing body. The currency would be generated through the process of bitcoin mining which is in full explained in bitcoin’s founding document (Nakamoto, 2009).

This crypto-currency provides various advantages when compared to fiat money (currency which derives its value from government regulation). For example, it provides a secure and efficient means of making payments at any time, and the data on bitcoin is readily available. The software behind it is open source, it reduces the risks merchants might face from frauds, and its operation and value are dictated by the community and its support system. It is not subject to the limitations of a governing body, with relatively low transaction costs being associated to trading with it. Moreover, it should be taken into account that bitcoin has the potential for high levels of divisibility, which can accommodate market prices and permit it to be future-proof and to resist inflation (Bitcoin.org).

Problems associated with bitcoin

When someone thinks of bitcoin, they think of the collapse of what used to be the biggest bitcoin exchange in the world, MtGox. It is reasonable to see why it would be unwise to write such an article without considering this scandal. The fact is that it is still unresolved, with legal action still being undertaken to recover the losses incurred by the users of the exchange.

The emphasis in this case needs to be directed to what led to this: a bug in the bitcoin software, which led to 'transaction malleability', which made it possible to duplicate bitcoin exchange transactions for no extra cost. Furthermore, questionable practice, such as poor auditing and a lack to keep proper track of customer accounts contributed to its downfall. This has been fixed ever since and improvements are being made to the software at a steady pace (Hern, 2014). The reader must bear in mind that bitcoin is an ever evolving piece of software and that time is needed for it to develop adequately, as well as the fact that this was a flaw of the way in which MtGox operated and not an inherent defect of the crypto-currency.

What is more, the use of bitcoin for illegal purposes has been at the heart of the arguments to ban it. Statistics have shown that a significant portion of illegal narcotics sales on the Deep Web (the side of the World Wide Web not indexed by standard search engines) are linked to the usage of bitcoin, such as the illegal online marketplace Silk Road which only uses bitcoin as a form of payment. It has also been reported to be used for money laundering and furthering of terrorist purposes (Twomey, 2013). The blame for the misuse of the virtual currency is not to be shifted unto bitcoin, but on the users, and as any instrument that aids trade in the world, it could be used for legitimate as well as illegitimate purposes. Nobody has decided to ban paper money because it could be used to purchase illegal narcotics anonymously, so why should bitcoin? Regulators should stay open minded and consider the support that bitcoin is gathering gradually, and attempt to accommodate evolution.

Developments of the legal stances on bitcoin in the US and UK

The legal stance on bitcoin is as of yet still stuck in a limbo of uncertainty, and while countries such as China have outright banned its usage (BBC, 2013), other countries have allowed the crypto-currency to work freely and are working on regulating its usage.

First, this section will look at developments in the United States of America concerning Bitcoin. It was recognised in law as a form of currency for the first time in a Texas Federal Court judgment (SEC v. Trendon T. Shavers and Bitcoin Savings and Trust, 2013), which held that Bitcoin is 'a currency or form of money'. Despite this, the Internal Revenue Service issued a 'Virtual currency guidance' which classifies Bitcoin as property, for federal tax purposes (IRS, 2014). This causes an issue for Bitcoin exchanges, as they have to make a report of every transaction that is undertaken in Bitcoin. This process results in a huge administrative burden, especially when some exchange customers engage in hundreds of transactions a year, which increase costs substantially.

The publication of new guidance by Financial Crimes Enforcement Network ruled that bitcoin exchanges and payment processors may be considered money services businesses under US law (FinCEN, 2014). This would force companies operating in this sector to seek proper licensing which could turn into a complicated, long and very costly process (Khan, 2014). Still, the New York Department of Financial Services (NYDFS) has formally announced at the Money 20/20 conference that it is considering creating Bit License which would benefit the interests of small businesses and start-ups (Rizzo, 2014). This may allow businesses to expand rapidly and it may grant better market access. It remains to be seen in what direction the NYDFS will go and if this could constitute a model for many other regulatory bodies.

The United Kingdom has taken an active interest in bitcoin by providing a more adequate regulatory framework. Even though Her Majesty’s Revenue and Customs has ruled that bitcoin qualifies as a 'decentralized currency' which is exempt from Value Added Tax (VAT) when it is exchanged for fiat currency, it is subject to standard VAT laws if used in transactions for goods and/or services. For example, when a transaction is made in bitcoin the VAT will be calculated for the value of bitcoin in fiat currency at the time of the transaction. On the other hand, bitcoin miners and exchanges are liable for corporation tax, income tax and capital gain tax for profits made. This decision was made with consideration to the stance of European Union law on VAT, and will be updated if need be (HM Revenue & Customs, 2014).

After having provided clarification in respects to bitcoin taxation, the UK government has also issued a consultation paper entitled Digital currencies: Call for Information (HM Treasury and Andrea Leadsom MP, 2014). This comes in line with the statement of the Chancellor of the Exchequer whose plans are being set in motion to turn Britain into the global centre of financial innovation. The aim is to get an input from the bitcoin community in order to better understand the advantages and risks of the digital currency as well as address areas which may need to be regulated. The consultation will end at the begining of December 2014 and there is a great degree of anticipation surrounding what stance the government will take in the following months.

Conclusion

Considering the advantages and disadvantages of bitcoin as well as the recent developments, this paper encourages a more liberal approach when concerning this area. A more adaptive and less restrictive regulatory intervention is to provide better security for traders using this virtual currency, as well as leaving it freedom to develop. The evident progressive attitude of the United Kingdom should be considered as a model in respects to how the law should be approaching this area, accommodating new technologies and ideas to flourish or wither, without direct restriction from state intervention.